The Inflation Reduction Act of 2022 ("IRA") provides generous tax credits for certain clean energy investments (e.g., 50% of the applicable basis in wind and solar farm projects). However, Treasury's proposed regulations implementing the credits would effectively prevent ERISA funds and other tax-exempt entities from taking full advantage. Comments on the proposed regulations are due by August 14, 2023.
Although employee benefit plans and other exempt entities typically cannot take advantage of tax credits, Congress intended to give tax-exempt entities cash payments from the government for certain tax credits generated by their investments in green energy projects (the "Direct Pay" election). However, Treasury's proposed regulations make it difficult for tax-exempt entities to use Direct Pay because the proposed regulations fail to account for ERISA plan asset regulations and the Internal Revenue Code's unrelated business income tax ("UBIT"). Specifically, the proposed regulations essentially require direct ownership of the green energy project in order to receive Direct Pay tax credits, but ERISA funds generally must use indirect investment vehicles (e.g., Venture Capital Operating Companies or intermediate pooled investment vehicles) in order to avoid prohibited transaction and fiduciary burdens. Similarly, tax-exempt organizations generally own investments indirectly to avoid incurring UBIT (e.g., through corporations that act as UBIT blockers). The proposed regulations do not provide a mechanism by which investing ERISA funds and tax-exempt entities may receive Direct Pay IRA tax credits when they invest indirectly.
Investments by pension and other ERISA governed funds in climate-friendly projects arguably may raise concerns that the deciding ERISA fiduciary impermissibly considered unrelated collateral environmental, social, or governance ("ESG") benefits of the investment rather than the financial returns. However, to the extent an investment in an environmentally friendly energy project produces IRA tax credits amounting to a higher return relative to other comparable investments, there is no reason to argue whether ESG related benefits are appropriate investment decision factors in order to justify that fiduciary decision. Thus, the larger and more certain the tax credits are, the clearer it may be that a plan fiduciary's investment decision was permissible under ERISA. As a result, the ability of an ERISA fund to gain the full advantage of the IRA tax credits will positively affect the ERISA ESG analysis regarding a plan fiduciary's decision to invest in IRA green energy projects.
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